India’s Growth: Potential/Forecasted vs Actual?

This is a fairly old paper (Sep 2007) but still is worth revisiting. It is written by Hiroko Oura of IMF and is a literature survey of the various research papers estimating growth of India.

With India’s GDP expanding at a rate above 8 percent in recent years, the debate about whether India is overheating revolves mainly about whether growth is above potential-that is, whether the economy is exceeding its “speed limit.” This paper attempts to shed light on this debate by providing up-to-date projections of India’s potential growth, including by clarifying differences in underlying assumptions used by various researchers that lead to a range of estimates. Estimates of potential growth on this basis range from 7.4 percent to 8.1 percent for 2006/07, and about 8 percent for the medium term.

Oura covers 4 papers that estimate India’s growth:

  Rodrik-Subramanian (2004) Poddar-Yi (2007) WEO (2006) Bosworth Collins (2006)
Potential Growth (2006-07) 6.8 8.8 8.1 7.4
Potential Growth (2007-08 to 2012-13) 7.3-7.6 9.5-9.8 8.7-9.0 8.0-8.4

All these 4 papers basically have used different methodologies to arrive at these growth numbers. And they have missed their mark widely. In 2006-07 the actual growth was 9.6% much higher than forecasted. An average growth rate of 8% plus from 2007-08 to 2012-13 looks very difficult as well with growth expected to touch 7% in 2008-09 and 6% in 2009-10. Even if growth recovers in 2010-11 and 2011-12 improve to 7% and 8% respectively,  average would still be 7.0-7.5%. Rodrik-Subramaniam might be the closest to the long-term forecast.

Though am worried about future growth forecasts, the question that always interests me is – How did India manage this average growth rate of 8.9% from 2003-04 to 2007-08. No model could forecast this high a growth rate. Out of the 4 papers mentioned abpove, 1 is in written in 2004, 2 in 2006 and 3 in 2007. So only the one in 2004 is applicable and it predicted 7.0% around levels. I had also analysed how private forecasters fared and realised they started forecasting higher growth rates only after the actual was higher than their previous forecasts.

Shankar Acharya and Arvind Virmani have presented their analysis which suggests surge in investment was the key. In 2004-05 average quarterly investment growth was 18.0%, 18.0% in 2005-06, 21.4% in 2006-07, 13.4% in 2007-08 and 11.0% in first half 2008-09. So, a slowdown seems to have already kicked in from 2007-08  and looks like quite sharp in 2008-09. It will be interesting to see invesstment fares in the next quarterely GDP data releases.

But what is still not understood is what led to the higher investments?

  • Was it because of expceted higher future growth? This then becomes full circle- investments rise because of future growth, and higher investments lead to higher current growth.
  • Was investment just bubble driven (see this paper by Cecchetti for details) where bubbles lead to optimistic  views on economy and drives high investment which then collapses as the bubble burst.
  • Was it conducive business environment  that led to higher investments? (though Doing Business Surveys suggest it has only worsened)
  • Was it economic polices?
  • Great Moderation worldwide?
  • Plain Good Luck?
  • The easiest of all answers- mix of all??

I still have not fully understood what did India do that it jumped to this near 9% growth trajectory and managed it for 5 continuous years? Any answers?

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